(Published by Nick McCullum on June 21)
Real estate investment trusts (REITs, for short) give investors a hands-off method to participate in the economic upside of owning and operating real assets.
REITs have grown in popularity over time as yield-starved investors seek alternative strategies to generate portfolio income.
On side effect of the growing popularity of REITs is the emergence of specialized REITs, focusing on only one subsector of the real estate industry.
Dream Office REIT (DRETF, Financial) (TSX:D.UN, Financial) is one example of this trend. As the largest pure-play office REIT in the Canadian market, this trust has a dominant position in the office property space.
At the security level, Dream makes a highly compelling investment proposition for high income investors. There are two reasons for this.
First, the company has a 7.8% dividend yield. This is more than four times as high as the average dividend yield in the S&P 500 and makes Dream one of the few companies with a 5%-plus dividend yield.
You can see the full list of all 416 stocks with 5%-plus dividend yields here.
The second reason why Dream is attractive is its dividends are paid monthly. Monthly dividends are ideal for retirees and other investors who require stable, predictable income from their investment portfolio. There are very few companies that pay monthly, rather than quarterly, dividends.
You can see the full list of all 29 stocks that pay monthly dividends here.
Dream Office’s high dividend yield and monthly dividend payments will catch the eye of high income investors.
Some due diligence, however, reveals the trust recently cut its dividend and is undergoing a seismic shift to its fundamental business.
Business overview
Dream Office is Canada’s largest pure-play office REIT. The trust has a market capitalization of $2 billion at current market prices. It is part of the Dream Unlimited family of real estate trusts, which also includes:
- Dream Industrial REIT (TSX:DIR.UN, Financial)
- Dream Global REIT (TSX:DRG.UN, Financial)
Dream Office and Dream Global share a CEO, P. Jane Gavan. Dream Industrial has a separate CEO named Brent Chapman.
Dream Office trades on the Toronto Stock Exchange under the ticker D.UN and is listed in U.S.-based stock databases under the ticker D.UN.TO or sometimes DRETF.
Dream Office’s strategic plan
At the beginning of 2016, Dream Office announced a strategic plan that was expected to transform its business and return the trust to fundamental growth.
The plan’s announcement came at an opportune time, as the trust’s stock had languished for some time. The strategic plan’s announcement saw a noticeable stock price increase from below $16 to around $20, circled in the diagram below.
Source: YCharts
For income investors, the key takeaway from this strategic plan was its dividend cut.
The trust had held its dividend steady for roughly a decade before a minor dividend increase in 2013. The strategic plan saw a decrease in Dream’s monthly dividend payment from 18.6 cents to 12.5 cents per unit (shown below).
Source: YCharts
Dream Office’s plan also contained a large asset divestiture plan, which categorized the trust’s existing properties into three buckets: Core, Private Market and Value-Add.
The core assets are self-explanatory – assets that are essential to the trust’s strategy and financial success.
Private Market Assets are defined as “fairly liquid, but not strategic to the longer-term objectives of the trust.”
The Value-Add Assets are where Dream’s strategic plan begins to get interesting.
These assets, located primarily in Alberta and Yellowknife (the remote capital city of Canada’s Northwest Territories), are characterized as “requiring active asset management or the passage of time prior to improving their demand profile and/or liquidity in the Private Market.”
The goal of the trust’s Strategic Plan was to systematically increase the quality of Dream’s real estate portfolio while divesting non-core assets in order to shore up its balance sheet. More specifically:
“The Trust intends to advance the Strategic Plan until the Core Assets represent substantially all of the Trust’s portfolio, with the goal of stabilizing the business by 2019. The proeeds from dispositions will be targeted to making the balance sheet stronger, investing in our buildings and opportunistically repurchasing our units, until such time as we see more attractive investment opportunities in the marketplace to redeploy the capital.” – Dream Office REIT 2016 Annual Report, page 7
While Dream Office’s strategic plan appears encouraging, many investors have found it hard to forgive the trust’s substantial dividend cut.
Certainly, there exist many other monthly dividend companies with superior track records of generating stable and growing dividend income. Realty Income (O, Financial) comes to mind.
Growth prospects
For the foreseeable future, the single largest influence on the REIT’s growth and financial performance will be the execution of the its strategic plan.
Indeed, the company has already made significant headway on this initiative since it was announced in February of 2016.
At the time of the announcement, Dream Office owned 166 properties totaling 23 million square feet of property with a portfolio occupancy of roughly 90%.
Source: Dream Office REIT 2017 Annual Meeting Presentation
Today, the trust owns 106 properties totaling 15.4 million square feet.
Notice the trust has divested from 36% of its properties (based on the number of properties owned), but only 33% of its total square footage. While this difference is small, it is significant because it suggests Dream is selling smaller, non-core properties (as planned).
Source: Dream Office REIT 2017 Annual Meeting Presentation
Dream’s business transformation can also be seen by looking at the company’s balance sheet.
In December 2015 (the most recent financial reporting period at the time of the strategic plan’s announcement), the trust reported total assets of $7.3 billion and total debt of $3.5 billion with a weighted average interest rate of 4.1%.
Source: Dream Office REIT 2017 Annual Meeting Presentation
As of March (today’s most recent financial reporting period), Dream Office has $5.1 billion of assets (a decrease of 30.1%) and total debt of $2.5 billion (a decrease of 28.5%).
The difference in changes between the trust’s assets and debt is likely due to the company earmarking some capital for share repurchases.
Investors should also note Dream’s weighted average interest rate has ticked downwards slightly, to 3.8% from 4.1%.
Source: Dream Office REIT 2017 Annual Meeting Presentation
The company's plan calls for the divestiture of assets and the elimination of debt. While this might not be a significant contributor to growth in funds from operations (the REIT equivalent of earnings per share), it de-risks the trust’s business model and positions it for a future without additional dividend cuts.
Competitive advantage and recession performance
Dream Office’s competitive advantage comes from owning some of the most iconic real estate in the Canadian market.
These properties include:
- Scotia Plaza in Toronto (the headquarters of the Bank of Nova Scotia (BNS, Financial)).
- State Street Financial Center in Toronto.
- Adelaide Place in Toronto.
- 5001 Yonge Street in Toronto (a major RBC hub).
- IBM Corporate Park in Calgary.
- Station Tower in Surrey, British Columbia.
As an office REIT, Dream is likely somewhat isolated from the effects of recessions. The company’s real estate (office centers) are in demand through all but the worst recessions.
With that said, Dream Office may feel a slight negative effect from the increasing number of workers electing to participate in the remote workplace economy. This is unlikely to have a meaningful effect on the REIT in the near term.
Valuation and expected total returns
Dream Office’s future shareholder returns will be composed of its current dividend yield, valuation changes and growth in its per-share funds from operations.
The REIT currently pays a monthly dividend of 12.5 cents, equivalent to total annual dividend payments of 1.50 Canadian dollars ($1.13) .
The company’s current stock price of CA$19.14 is trading at a dividend yield of 7.8%. American investors should keep in mind that since Dream’s dividend payments are delivered in Canadian dollars, they are prone to fluctuations in the exchange rate.
To assess a REIT’s valuation, the traditional price-earnings ratio cannot be used because these real estate investment vehicles incur significant amortization and depreciation charges that artificially impair GAAP EPS.
Instead, alternative valuation metrics must be used. These include price-to-funds from operations, price-book and price-NAV, among others.
However, the most practical valuation metric for REITs is to compare their current dividend yield to their long-term historical dividend yields.
Dream Office’s current dividend yield of 7.8% is compared to its long-term average below.
Source: YCharts
The company’s current dividend yield is 7.8% and its average dividend yield since 2004 is 8.3%.
The trust’s dividend yield is actually lower than average, meaning it may be moderately overvalued at current prices.
For high income investors, there are better alternatives in today’s market, although high single-digit returns are possible based on Dream’s dividend yield alone.
Final thoughts
Dream Office’s exceptionally high dividend yield and monthly dividend payments make it very appealing at the security level.
Some due diligence reveals the trust recently experienced a dividend cut (which would trigger an automatic sell using The 8 Rules of Dividend Investing) and is trading at a lower dividend yield than its historical average.
Thus, there are better REITs on the market today, like Omega Healthcare (OHI, Financial)Ă‚ or Welltower (HCN, Financial).
Disclosure: I am not long any of the stocks mentioned in this article.
